The demise of the Nation State?
Vito Tanzi

Over much of this century government expenditure, expressed as a share of Gross Domestic Product (GDP), rose in all industrial countries. The increase was particularly large in the period after 1960. For all the industrial countries for which data are available, general government expenditure rose from an unweighted average of about 28 percent of GDP in 1960 to about 46 percent of GDP in 1996 (Table 1).

The growth in public expenditure was promoted by technical, social, and political factors. Among the technical factors, the discovery or the popularization of concepts such as public goods, externalities, and merit goods gave increasing legitimacy to the government's actions in many areas. Among the social factors, growing concern for income distribution, as well as for income maintenance for workers, retirees, or other groups, and for economic stabilization in general, provided additional reasons for increasing public expenditure. In general, governmental activity was directed toward the alleviation of various risks (unemployment, poverty, illiteracy, poor health, foreign domination, etc.) and this alleviation was supposed to be achieved through higher public spending. See Devarajan and Hammer (1997). Among the more political factors, there were attempts by governments, who were not always convinced about the virtue of the market, to replace the market in many resource allocation decisions. Governments came to play major roles in promoting industrial and regional development and in employment policies, through the use of tax expenditures, subsidized credits, and budgetary subsidies to enterprises.1 The assumption was that the government could improve on the results that the market would achieve on its own. See Tanzi (1997)

For a long time, increases in government spending were largely financed by tax increases. However, as the level of taxation rose, countries began to run into taxpayers' resistance and had to rely on borrowing. This in turn led to the growth in public debt and in interest payments. Eventually, this line of financing was also exhausted or became too expensive when the share of debt into GDP reached high proportions and affected the level of real interest rates at which governments could borrow.

The main tax instruments used for financing the higher levels of public spending were:
(a) taxes on income and especially on personal income;
(b) value-added taxes; and
(c) social security contributions paid partly by the workers and partly by the employers. Revenue from these relatively new taxes increased sharply in recent decades. These developments were largely, though not entirely, associated with actions by national governments.

1 Regulations also played a major role.